Vanguard exec: Don't ditch bonds when rates rise

BOSTON -- Tim Buckley may be today's most influential fund industry leader, measured by his impact on how Americans' retirement funds are invested.

In January, he became chief investment officer at Vanguard, the largest mutual fund company ranked by assets. Buckley reports to CEO William McNabb, but has a bigger impact on investment policy. He oversees about $2 trillion in Vanguard's stock, bond and money-market funds.

Buckley, 43, joined the Valley Forge, Pa.-based company in 1991 as assistant to Vanguard's chairman at the time, John Bogle, the index mutual fund pioneer who founded the company. Buckley led the Vanguard unit specializing in products for individual investors before being promoted this year. He's just the second CIO in Vanguard's nearly four-decade history. His predecessor, George "Gus" Sauter, became the first CIO in 2003.

Buckley says he's open to adjusting the company's fund lineup and services, but doesn't expect any changes that might conflict with Vanguard's focus on low-cost funds.

"I've been thinking the Vanguard way for all my 22 years here, and I espouse the same investment philosophy as anyone else in a leadership position here," Buckley says.

Indeed, it's unlikely that Vanguard might wish to make any radical changes, given the company's rapid growth. The $2 trillion currently under management is double the total four years ago. Vanguard's mutual funds and exchange-traded funds attracted $140 billion in new cash last year, a record for the company. Through March of this year, net deposits total about $52 billion.

The market has climbed to new heights during Buckley's first three months as CIO. Although stocks are up 9 percent this year, the market has wavered between small losses and gains the past three weeks as investors question whether the rally is sustainable. Meanwhile, bond yields remain near all-time lows.

Buckley offered his thoughts on the long-term outlook in an interview this week. Here are excerpts:

Q: Bond funds continue to attract cash, despite the well-known risks of short-term losses when interest rates eventually rise. How should investors manage their bond portfolios in this environment?

A: When rates rise, they could go up quickly. We worry about people suddenly saying, "OK, it's time to get out of bonds, rates are up. I saw a short-term loss in my bond portfolio, so I'm going into stocks, or into cash." That behavior is rarely rewarded.

Remember that you're investing in bonds for a reason: because they often move opposite of where the stock market is going. They help mute the volatility of stocks. You should own bonds with a long-term approach. Set your asset allocation and stick with it, and it will prove to be successful over the long run.

Q: What about stocks? The market climbed to a record high last month, and lots of investors are getting back in. What are the key things they should be thinking about?

A: Invest with a long time horizon and make sure you understand your goals. Don't ask, "Should I buy or sell?" but ask "What am I trying to achieve in the market, and what needs am I trying to meet?" Set your absolute goals and base everything off that. Don't get into a mindset of, "I want to outperform the other guy, or other funds." I'm not saying you should never make relative performance comparisons at some point. You do want to evaluate performance, but your goals should be absolute goals.

Q: Investors have taken money out of stock mutual funds for the past six years in a row. But that trend may be coming to an end, with cash being added this year. Do you expect it to continue?

A: Investors are clearly coming off the sidelines, whether you're looking at flows across the industry or just at Vanguard. But you can't make a trend out of a couple months. The good news is that people are getting back into stocks again. If you're investing for the long run, that's still where we believe the growth potential is. We just hate to see the cases where an investor is only now coming back into the market, after staying out over the past five years. You don't want to see people chase performance, and investors have a bad habit of doing that. And the recent flows would back that up.

Q: Vanguard has long argued that many U.S. investors have a home bias in their portfolios -- that is, they're not investing enough in foreign stocks relative to how much they own in the U.S. Yet recently, U.S. stocks have outperformed nearly all the foreign indexes. Does that argument still make sense?

A: As much as 30 to 40 percent of your stock portfolio could or should be held internationally. At that level, you can get the benefits of diversification. We don't tell people, "Go international, because the returns will be better." Instead, it's about diversifying your stream of investment returns. The returns generated by U.S. stocks won't be correlated 1-to-1 with foreign stocks. They will move differently.

But if you've got more than 40 percent of your stock portfolio in international stocks, the benefits of diversification start to wane. It's important to remember that investing in foreign stocks still costs more than domestic investing. (For example, most foreign stock funds charge higher expenses than domestic stock funds.) Those added costs can outweigh the benefits of going international. With that cost trade-off, you have diminishing returns if you've got more than 40 percent international.

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